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Chapter 6

Annual Cash Flow Analysis

Lesson 5: Chapter 6
Annual Cash Flow Calculations
Annual Cash Flow Analysis
Applying Annual Cash Flow Techniques
Useful Lives Equal the Analysis Period
Useful Lives Different from the Analysis Period
Infinite Analysis Period

Energy Star Appliances


Based on type, major appliances have life-spans of 7 to 15
years with refrigerators having the longest. If a family stays
in a residence on average for eight years, what
considerations should a family use in deciding whether to
keep their major appliances when moving or to leave them
with their residence?

Given the data above, which appliance replacement


decision would be more sensitive to changes in the cost of
electricity, the clothes washer or the refrigerator? How
would you explain your answer to someone not skilled in
engineering economics?
When 9th edition came out EnergyGuide labels were not
required for TVs, ranges, ovens, and clothes dryers. What
has changed?
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Annual Cash Flow Calculations


A student bought $1000 worth of furniture.
What is the equivalent annual cost if it is expected to
last 10 years and the interest rate is 7%?

10

P=1000

= 1000 , 7%, 10 = $142.40


Basically express all varibles in terms of A
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Annual Cash Flow Calculations


A student bought $1000 worth of furniture.
What is the equivalent annual cost if it is expected to
last 10 years and can be sold for $200?
S=200
0

10

10

P=1000

= 1000 , 7%, 10 200( , 7%, 10) = $127.92**


= 1000 200 , 7%, 10 + 200(7%) = $127.92
= 1000 200 , 7%, 10 + 1000(7%) = $127.92

Annual Cash Flow Calculations


What to do when you have salvage value
S
0

This S happens in the future, so you treat is as an F

n-1

= ( , , ) ( , , )
= ( )( , , ) + ()
= ( )( , , ) + ()
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Annual Cash Flow Calculations


225

Year

Maintenance and
Repair Cost

45

90

180

135

225

PWCost

180
135
90

45

= 45( , 7%, 1) + 90( , 7%, 2) + 180( , 7%, 3)


+135 , 7%, 4 + 225( , 7%, 5) = $531
= 531 , 7%, 5 = $130

Annual Cash Flow Calculations


Year
1
2
3
4
5

Maintenance
and Repair Cost
45
90
135
180
225

225
135

180

90
45
0

= 45 + 45 , 7%, 5 = $129
This value is already an A, so we dont need to do anything to it

Criteria: Annual Cash Flow Analysis


Situation

Criterion

Neither input nor output


fixed: Typical situation

Maximize EUAW (Equivalent


Uniform Annual Worth)
EUAW = EUAB - EUAC

Fixed input: amount of


money or other input
resources are fixed

Maximize EUAB (Equivalent


Uniform Annual Benefits)

Fixed output: fixed task,


benefit, or other outputs

Minimize EUAC (Equivalent


Uniform Annual Costs)

Annual Cash Flow Analysis


Equal useful lives

EUAW = EUAB EUAC


Device B

Device A

300

A=300
0

1
P=1000

350 400
2

450

500

P=1350

= 10,00 , 7%, 5 + 300


= 10,00 0.2439 + 300 = $561
= 1,350 , 7%, 5 + 300 + 50 , 7%, 5
= 1,350 0.2439
+ 300 + 50 1.865 = $640
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Annual Cash Flow Analysis


Multiple alternatives, 10 yrs 8%
Plan A

Plan B

Plan C

Installed cost of equipment

$15,000

$25,000

$33,000

Material and labor savings per year

$14,000

$9,000

$14,000

Annual Operating expenses

$8,000

$6,000

$6,000

End-of-useful-life salvage value

$1,500

$2,500

$3,300

EUAB =

Plan A
$14,000
104
$14,104

Plan B
$9,000
172
$9,172

Plan C
$14,000
228
$14,228

EUAC =
EUAW = EUAB EUAC =

$2,235
8,000
$10,235
$3,869

$3,725
6,000
$9,725
-$553

$4,917
6,000
$10,917
$3,311

Material and labor savings per year


Salvage value * (A/F, 8%, 10)

Installed cost * (A/P, 8%, 10)


Annual Operating expenses

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Annual Cash Flow Analysis


Initial cost
End-of-useful-life salvage value
Useful life, in years

Pump A
$7,000
$1,500
12

Pump B
$5,000
$1,000
6

= 7000 1500 , 7%, 12 + 1500 7%


= $797
= 5000 1000 , 7%, 6 + 1000 7%
= $909
If EUACB was calculated over 12-year period

= 5000 + 5000 1000 , 7%, 6


+ 1000(7%) = $909

, 7%, 12

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Annual Cash Flow and Analysis Period


Analysis Period Equal to Alternative Lives
Economic study is based on the analysis period

Analysis Period a Common Multiple of Alternative


Lives
Under the assumption of identical replacement, economic
study is based on alternatives own lives

Analysis Period for a Continuing Requirement


Under the assumption of identical replacement, economic
study is based on alternatives own lives

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Annual Cash Flow and Analysis Period


Infinite Analysis Period
Under the assumption of identical replacement,
economic study is based on alternatives own lives
Some Other Analysis Period
Need to estimate the terminal values for all alternatives
at the end of the analysis period

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Analysis Period for a Continuing Requirement


Pump A

Pump B

Initial cost

$7,000

$5,000

End-of-useful-life salvage value

$1,500

$1,000

12

Useful life, in years

= 7000 1500 , 7%, 12 + 1500 7%


= $797
= 5000 1000 , 7%, 9 + 1000 7%
= $684

This comparison of "different-life" alternatives assumes


identical replacement (with identical costs, performance, etc.)
when an alternative reaches the end of its useful life.
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Infinite Analysis Period


Tunnel
Initial cost

Maintenance
Useful life
Salvage value

Pipeline

$5.5 million

$5 million

Permanent

50 years

= = 5.5(6%) = $330,000
= 5.5( , 6%, 50) = $317,000

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Analysis Period
Alternatives
Initial Cost

Alt. 1
$50,000

Alt. 2
$75,000

Estimated salvage value at end of useful life

$10,000

$12,000

Useful Life
Estimated market value, end of 10-year

7 years
$20,000

13 years
$15,000

1 = 50,000 +

10,000 50,000 , 8%, 7 +

20,000 , 8%, 10 = $64,076


1 = 1 , 8%, 10 = 64,076 0.1490 = $9,547
2 = 75,000 + 15,000 , 8%, 10 = $69,442
2 = 2 , 8%, 10 = 69,442 0.1490 = $10,347

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Spreadsheet Annuity Functions to Analyze Loans


Please repeat the following examples using Excel
Excel Functions

Purpose

PV (i, n, -A, [F], [Type])

To find loan balance given i, n, and A

PMT (i, n, -P, [F], [Type])

To find payment per period (A) given i, n, P

IPMT (i, x, n, -P, [F], [Type]) To find the interest portion in the xth payment
PPMT (i, x, n, -P, [F],
[Type])

To find the principal portion in the xth


payment

NPER (i, -A, P, [F], [Type])

To find remaining periods to payoff the loan

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Analyzing a Loan with Spreadsheet


Loan of $2400 at interest rate of 6% per year nominal
for 6 months
Monthly Payment

Month
0
1
2
3
4
5
6

= 2400 , 0.5%, 6 = $407


= (0.005, 6, 2400)
Interest
Payment

12.00
10.02
8.04
6.04
4.04
2.03

Principal
Payment

395.03
397.00
398.99
400.98
402.99
405.00

Ending
Balance
2400.00
2004.97
1607.97
1208.98
807.99
405.00
0.00

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Analyzing a Loan with Spreadsheet


What is the balance due when halfway through a 48-month
loan of $15000 at 9% nominal rate?
Monthly Payment

= 15,000 , 0.75%, 48 = $373.28


= (0.005, 6, 15000)
Balance at the end of 24 months (24 months remaining)

24 = 373.28 , 0.75%, 24 = $8170.78


= (0.0075, 24, 373.28)

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Analyzing a Loan with Spreadsheet


Maria has a 30-year mortgage of $100,000 at 7.5%. She
just made her 12th payment. She also pays $200 each
month for insurance and property tax.
Monthly Payment
= 100,000 , 0.625%, 360 = $699.21
= (0.00625, 360, 100000)
Balance at the end of 12 months (348 months remaining)
12 = 699.21 , 0.625%, 348 = $99,077.53
= (0.00625, 348, 699.21)

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